So we have only seen the trailer of the Newt-financed takedown of Bain Capital, but it appears that even Republicans are confused about whether private equity capital firms like Bain practice "good capitalism" or "bad capitalism." So far, in my experience, both sides have missed the story here, the relationship of Bain to its "cash cow" takeovers. The first story here is that most of the takeovers are NOT "troubled companies," rather are these profitable "Cash cows."
I was in the senior management of a cash cow company that went through three ownership changes over my nineteen years of tenure, the last being a Bain-like equity capital firm, each trying a "flavor-of-the-day" theory for extracting value from the company. "Cash Cows" were first named in the classic Boston Consulting Group matrix that divided the business world into four groups depending on market share and growth - cash cows, stars, question marks and dogs. Cash cows are characterized by low growth and a decent market niche.
My company, like many cash cows, had a small, close group of owners (often family). Cash cows usually have a decently-profitable market niche, and are often located away from the major business hubs. Long-time employees are the norm, most good and fervently loyal, with a few turkeys nobody has the heart to fire. We did not have a bevy of tax accountants trying to exploit every tax preference, and the owners did not like debt. As a result, we could survive a long time on good cash flows and decent profits, paid to the owners as dividends.
What Bain and the others know is that these cash cows are ripe for "milking." Since debt is low, they can bring in lots of outside debt to buy out the owners, immediately "lever" profits, and get the debt interest tax deduction that the prior owners had "left on the table." Next, instead of paying those big dividends, you use the good cash flow to pay the interest. You replace the management (I left twice and was asked to return both times), along with many of the long-term employees in order shake things up and to try to jump-start some growth.
If the growth strategy succeeds, the private equity firm now has "capital gain" profits to pass on, as well as "carried interest" bonuses to the equity capital partners, which both have less than half the tax liability of those old dividends (see my earlier diary, Bain Survives on Three Tax Breaks).
If the new growth strategy fails, as happened to Bain with Kansas City's GST Steel, the company switches to "salvage mode." Since the company had not been aggressively managed for tax benefits in the past, there are likely assets that can be sold or written off for more tax advantages. So, as happened with GST Steel, the equity capital partners can stiff the creditors with the losses and still come out ahead on cash and tax write-offs.
So, in short, the Bain Capital form of capitalism is based on exploiting cash cow companies for their tax advantages. Sometimes this works very well, and Bain makes huge profits. Sometimes this fails, and Bain still makes smaller profits.
Nice work if you are the kind of person who can change your recollection of your own past decisions at will, in order to tell yourself what a great, moral guy you are.